Something new in Yellen’s speech: ‘Pent-up wage deflation’

There was a lot of on-the-one-hand, on-the-other-hand discussion of the jobs market in Federal Reserve Chairwoman Janet Yellen’s speech in Jackson Hole. But one novel element was her discussion of “pent-up wage deflation.”

Here’s Yellen:

The sluggish pace of nominal and real wage growth in recent years may reflect the phenomenon of “pent-up wage deflation.” The evidence suggests that many firms faced significant constraints in lowering compensation during the recession and the earlier part of the recovery because of “downward nominal wage rigidity”–namely, an inability or unwillingness on the part of firms to cut nominal wages. To the extent that firms faced limits in reducing real and nominal wages when the labor market was exceptionally weak, they may find that now they do not need to raise wages to attract qualified workers. As a result, wages might rise relatively slowly as the labor market strengthens. If pent-up wage deflation is holding down wage growth, the current very moderate wage growth could be a misleading signal of the degree of remaining slack. Further, wages could begin to rise at a noticeably more rapid pace once pent-up wage deflation has been absorbed.

“The prevalence of downward nominal wage rigidities spikes in recessions as unemployment rises, but remains high well after unemployment begins to come down,” wrote Mary Daly and Bart Hobjin.

The gist of it is companies were reluctant to cut employee salaries despite the weak jobs market during the recession. So now that the jobs market is improving, companies are reluctant to pass out raises they otherwise would have done.

This is a hawkish interpretation of what’s going on, and if correct, it would argue for somewhat more aggressive rate hikes than otherwise would be the case. Keep in mind that Yellen balanced out her presentation with other, more dovish assessments.